10 Biofuel Trends Worth Watching

1. Sector downgrades

Biofuel stocks have been weathering downgrades, primarily on the ethanol side. Goldman Sachs analyst Arjun Murt cited poor pricing and cost outlooks in cutting his share price targets and said that there might be a “dead cat bounce” proving short term gains as investors took advantage of the low stock price, but that fundamentally the stocks would continue their downward spiral.

Ethanol downgrades hurt Big Ethanol companies such as VeraSun (VSE), Pacific Ethanol (PEIX), Aventine Renewable Energy (AVR), and Archer-Daniels-Midland (ADM) although the latter plays in many markets and is not as exposed to ethanol.

2. Biodiesel, the “rock star of fuels”

“Biodiesel is the rock star of fuels,” said Will Thurmond, author of Biodiesel 2020: A Global Market Survey, in a glowing review of biodiesel entrepreneurs and companies published by money.cnn.com.”

The pitch? Biodiesel requires no engine modifications and no loss in power, so it is an easier conversion. Plus. it has a cult-like following including many celebrities, which makes it less subject to price. Finally, fleet conversions – which typically involve diesel-engine trucks — are happening much faster than consumer conversions.

Expect to see IPOs discussed and/or launched by Renewable Energy Group, which controls 27% of US biodiesel production, and Imperium Renewables, the Paul Allen-backed venture. Nova Bioenergy has a strong biodiesel story among already-public stocks.

3. Algae-based Biodiesel

Algae sounds icky but it’s big business. Valcent, which developed the Vertigo system for growing algae on a commercial scale projects that it can produce 100,000 gallons of algae oil per acre per year, or 233 times the land productivity of corn ethanol.

That’s enough productivity to supply the whole of US gasoline consumption off 2,817 square miles of cultivation, and fully renewable. If Valcent and other competitors can make algae biodiesel commercially scalable, it might be “game over” for gasoline.

All it requires are algae cells, water, and carbon dioxide. Cost to replace all US gas consumption? 1.4 trillion. That will have to come down. But so would the price of fuel, about 30%. And no trade deficit.

4. Bio-crude

Archer-Daniels-Midland announced a partnership with ConocoPhillips to produce “biocrude”, a hydrocarbon fuel made from biomass with similar properties to crude oil, which can be refined into gasoline or diesel. ConocoPhillips had previously announced a partnership with Tyson foods to develop chicken-fat based biodiesel. ADM had indicated previously its strategy to diversify beyond its base in corn ethanol.

5. New plant construction…or not?

New plants continue to spring up around the country. Look for a continuing pressure to consolidate. Publicly traded companies may find equity raising tough in this environment, but as production capacity ramps up, access to fuel markets will become more important to avoid being on the wrong side of a glut.

New plants have been announced this week, or advanced in the permitting phase, for Missouri Illinois, Kentucky, Indiana, Tennessee, Kansas, Georgia, South Carolina, and Arizona. New plants opened in Oregon and Pennsylvania.

6. Food vs. fuel

A jihad on biofuels is underway with critics saying that biofuel production is driving up crop prices. Don’t believe it – crop prices are rising because of rising incomes in the developing world and numerous crop failures in Europe and Asia. But, believe that many people have fallen for the lie, and the resulting hub-bub won’t make it any easier to get corn ethanol plants approved. It’s easier right now to finance plants that use animal fats (tallow), waste oils, or non-food stocks such switchgrass or jatropha.

Brazilian President Luiz Inacio Lula da Silva pointed out that only 20 percent of arable land in Brazil is currently under cultivation and less than 4% is used for ethanol. “This is not a choice between food and energy,” he said. “The problem with world hunger is not a shortage of food but a shortage of income.”

7. Infrastructure

All over the world, biofuels are hindered by problems in infrastructure. In the US, the lack of an ethanol pipeline makes ethanol expensive and in short supply outside the Midwest. Good roads or rail are in short supply in countries that provide feedstocks to the US. 2009 will see more of these problems addressed, but shortages and delays could be a steady diet for biofuel blenders and producers in 2008.

8. Questions about emissions.

A report by Nobel Prize winning chemist Paul J. Crutzen said that crops used in the US and Europe to make biofuels were speeding up global warming. The report sated that use of canola, or rapeseed, to produce biodiesel resulted in 70% higher emissions than diesel, taking into account the use of fertilizers. The report found that the fertilizers release nitrous oxide, which is 300 times more insulating than carbon dioxide.

That’s tough news for an industry that has grown because of its eco-friendly characteristics.

Look for anti-biofuels advocates to focus more and more on emissions studies, but at the same time be skeptical about anti-biofuels research. An anti-biofuels report that was released last week by the OECD turned out to be …. not from the OECD. It was a draft discussion paper prepared for an OECD affiliate, but it was given official status for almost a week in the media before officials at the OECD corrected the error.

9. Prices

Ethanol prices are at $1.70 per gallon, which is great for the consumer but awful for producers. The culprit is lack of a pipeline and the lack of E85 stations, but until ethanol goes back over $2.000 there will be severe profit pressure on ethanol producers.

10. Oil company retaliation

Oil companies don’t like biofuels. Why should they? It’s competition.

But Business Week ran a stinging article on the underhand efforts of oil companies to slow the spread of E85. According to the magazine, the oil industry has been funding anti-biofuel studies, funding “food vs fuel” organizations and is dragging its heels on launching E85 through their own brands.

The losers? Car makers. They have invested in E85 to avoid increased CAFÉ emission caps, which they say will cost them $100 billion. If the car makers succeed in getting E85 going, they are undervalued stocks. If they fail and the $100 billion CAFÉ bill has to be paid, they are overvalued.

Oil and natural gas producers Venezuela and Bolivia have criticized ethanol production for increasing food prices and world hunger. and Cuba has seen the opportunity to join the leftist countries as a means of opposing the US.

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Jim Lane does not own any of the stocks discussed in this article.